A beefed-up tax bill is landing on a doormat near you soon. What are you going to do about it? The answer depends largely on what kind of firm you are, and ultimately how well you manage your finances.
The changes to tax on work in progress (WIP) introduced by the Accounting Standards Board (ASB) are aimed at providing clarity in existing reporting standards. What they appear to have done accidently is introduce panic into the legal market.
The ASB has gone further than anyone could have predicted. Currently, the value of WIP in an average firm is around 30 per cent of the selling price. What FRS5 application note G (snazzy name) does, by bringing equity partner time into the equation, is to make a firm account for income as soon as it obtains a right to consideration for the work it’s done. In other words, any work that’s under way, but has not yet been billed.
Suddenly, firms will move from a costs-based evaluation excluding equity partner time to a selling-price evaluation based on what they would get for the job if they were to pursue the right to be paid. And that’s a big differential.
The hardest-hit firms will be those with a large number of equity partners and low leverage, or those heavily reliant on work with a long tail, such as personal injury or publicly-funded matters.
Imagine the joy of those Norton Rose partners, already waiting two years for all of their profits, when it sinks in that the rest may be withheld to pay the tax. Ditto Linklaters, with its bells-and-whistles IT system holding up distributions. And it’s a fair bet that Clifford Chance is at least in the same water, if not in the same boat. Set that against the giant of efficiency that is Slaughter and May, which distributes its profits every month once the costs have been covered.
In the end, handling the tax hike will come down to sound financial management. The real argument may be not with the Inland Revenue to try and spread the pain, but to decide internally how much will be funded out of withheld profits and how much will be funded out of increased bank borrowings. The Lawyer 100 raised these tortuous issues in great detail for the first time last year. We’re already looking forward to the next issue in September.